By Arthur I. Cyr
Scripps Howard News Service
The extended Wall Street turmoil resulting from the housing recession and subprime lending crisis contains opportunities as well as major challenges. This is generally glossed over by scare headlines warning of impending disaster.
Optimistic declarations by President Bush, Treasury Secretary Henry Paulson and others do conjure eerie images of the unfortunate President Herbert Hoover, who stressed that the economy was "fundamentally strong" even as the greatest economic collapse in modern history was unfolding.
This is fundamentally ironic, because the U.S. economy actually is very strong. Economic output has been slowing but not dramatically contracting, and unemployment remains low, at approximately 5 percent. Pessimists rightly point out that discouraged job seekers have disappeared from the jobless statistics. At the same time, pervasive "Help Wanted" signs in retail outlets and elsewhere show that jobs remain available, though generally not of the ideal sort.
Nonetheless, a severe Wall Street slump could easily bring recession. In the past few days, the government has facilitated the purchase of bankrupt Bear Stearns by J.P. Morgan Chase and lowered interest rates still further. The immediate dramatic upswing on Wall Street shows that global capital remains readily available for investment in the United States.
Basic economic policy challenges facing American leaders are very important, but subtler than headlines indicate. First, the Federal Reserve system once controlled the money supply as well as interest rates, but no longer. Starting with World War II, the U.S. dollar has been essentially freely convertible, as part of a very successful basic strategy to encourage global commerce. Farsighted leaders in the Franklin Roosevelt and Harry Truman administrations laid the foundation for our enormous long-term world economic success.
A byproduct has been the growth of dollar holdings overseas, reducing the influence of the Fed. No one knows exactly how much of the world dollar supply is directly managed by our federal reserve banks, though informed estimates range from 20 percent to one-third. Former Fed Chairman Alan Greenspan's easy money policies, and celebrity style, tended to mask this fact of life. By contrast, throughout the 1950s, Fed Chairman William McChesney Martin remained largely invisible to the American public though extremely powerful.
Second, constant interest-rate cuts over time have diminishing positive effect, while adding to downside risks. The great British economist John Maynard Keynes warned about this phenomenon, which he described as the "liquidity trap." A slowing economy is like a great sailing ship trapped in a calm windless sea. As the interest rate approaches zero, government loses a fundamental tool to spur economic activity.
Current Fed Chairman Ben Bernanke so far has headed off a global financial panic, but the principal instrument of rate cuts cannot be used much longer. A respected student of the Great Depression, he has looked to fresh innovation, including making federal funds directly available to investment banks.
Third, general market forces remain robust and available to promote growth in the United States. The very weak dollar encourages exports, especially in manufacturing, but in services as well. This is particularly important for the industrial Middle West. The situation also makes many domestic assets attractive investment opportunities.
Media preoccupation with very negative news, especially the collapse of the subprime mortgage market and the associated housing recession, oversimplifies a very complex economy.
Arthur I. Cyr is Clausen Distinguished Professor at Carthage College, Kenosha, Wis. Cyr can be reached at
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